LONDON (MarketWatch) - European Central Bank President Jean-Claude Trichet opened the door to rate cuts as early as next month on Thursday after the euro-zone's top monetary policy maker acknowledged diminishing inflation risks and growing threats to economic growth across the 15-nation euro zone from the worsening credit crunch.

"With the weakening of demand, upside risks to price stability have diminished somewhat, but they have not disappeared," Trichet said at his monthly news conference following the meeting of the rate-setting Governing Council.
Also, Trichet said the council had pondered the possibility of a rate cut before voting unanimously to leave its benchmark rate unchanged at a seven-year high of 4.25%.
While Trichet said the ECB would be closely watching for inflation pressures, the remarks clearly signal that the ECB "now has completely free hands after having removed any potential bias more or less linked to inflation," said Aurelio Maccario, chief euro-zone economist at UniCredit MIB in Milan.
"This means they can cut rates anytime from November onwards, either because of a further deterioration in the financial markets situation or because of a worsening macro outlook," Maccario said.
"The general tone of the ECB statement and Mr. Trichet's comments suggest to us that the ECB will cut interest rates from 4.25% to 4.00% in November," said Howard Archer, chief European economist at Global Insight. "If they do not act then, we suspect a move will only be delayed until December."
Market mover
Financial markets responded accordingly. Credit markets fully priced in a November rate cut; German government debt yields fell and the yield curve steepened, with the short end, which is most sensitive to official rate expectations, leading the way.
The euro, which had dipped to a one-year low ahead of the ECB meeting, extended losses to sink below the $1.3800 level against the dollar. See Currencies.
Not all observers were convinced the cut would come next month, however. While Trichet clearly signaled the ECB's bias is toward a cut, he didn't deliver the type of clear-cut statement that signals a move is imminent at the ECB's next gathering, said economists at Capital Economics.
"For now, we are penciling in the first move in December. The ECB has signaled changes in interest rates very clearly using 'code language' in the past and we do not think that today's comments were strong enough to imply that it plans to act at its next meeting," they wrote, but acknowledged that ECB officials could use speeches before the next meeting to signal that a move was imminent.
Trichet acknowledged extreme levels of uncertainty as a result of financial turmoil. But he also repeated cautions that the central bank, which has a sole mandate to preserve price stability across the 15-nation euro zone, was concerned about rising wage growth amid falling economic activity and labor productivity.
Still, the language overall was seen as an acknowledgement the central bank has come to the end of a long tightening cycle that likely ended with a quarter-point rate hike in July that took the key lending rate to 4.25% in an effort to anchor inflation expectations amid surging food and energy prices.
Since then, energy prices have retreated and the pace of inflation has slowed. Eurostat, in a preliminary estimate, pegged September consumer inflation at an annual rate of 3.6%, off from 3.8% in July and 4% in August, but still well above the ECB's medium-term target of near but just below 2%.
Importantly, Trichet welcomed data that showed inflation expectations have declined, Maccario noted.
Ducking bias
Asked to describe the council's "bias" on future rate moves, Trichet refused to answer. That's a deviation from Trichet's previous assertions he had "no bias" on future rate moves and a signal in itself that the council has adopted an "easing bias," Maccario said.
The euro, which had dipped to a one-year low ahead of the meeting on expectations Trichet would soften the tone on inflation, extended losses against the dollar following the remarks, sliding below the $1.3800 level.

Not all economists had expected Trichet to significantly change his tune. With inflation still running well above the ECB's 2% annual target, the ECB chief did reiterate fears that price pressures could feed through to the wage-setting process.
And the demand by influential German trade union, IG Metall, for an 8% wage rise appeared to reinforce the Governing Council's worries about such "second-round effects.
Indeed, Trichet did warn that the ECB is closely watching wage talks across the euro zone and again urged the abolition of measures that tie wage hikes to consumer price inflation.
The euro-zone's deteriorating growth outlook was underscored Wednesday, when the Markit euro-zone manufacturing PMI fell to 45.0 in September, its lowest level since December 2001, signaling an accelerating contraction of manufacturing activity across the 15-nation region. See full story.
A comparable rate of decline hasn't been seen since the Sept. 11, 2001 terror attacks and indicates the manufacturing sector is leading the euro zone into recession, said Chris Williamson, chief economist at Markit, noting that it's likely that the full impact of the worsening financial crisis has yet to be felt.
Other confidence gauges have also deteriorated. Germany's Ifo business-climate index collapsed to recession levels in September, economists said, while unemployment across the euro zone is on the rise. And Ireland last week became the first euro-zone nation to meet a widely-used definition of recession, posting a second consecutive quarterly decline in gross domestic product.